Saturday, August 05, 2006

How many billions (or trillions) of dollars depends on how you do the accounting

The federal government keeps two sets of books.The set the government promotes to the public has a healthier bottom line: a $318 billion deficit in 2005.The set the government doesn't talk about is the audited financial statement produced by the government's accountants following standard accounting rules. It reports a more ominous financial picture: a $760 billion deficit for 2005. If Social Security and Medicare were included — as the board that sets accounting rules is considering — the federal deficit would have been $3.5 trillion.Congress has written its own accounting rules — which would be illegal for a corporation to use because they ignore important costs such as the growing expense of retirement benefits for civil servants and military personnel.Last year, the audited statement produced by the accountants said the government ran a deficit equal to $6,700 for every American household. The number given to the public put the deficit at $2,800 per household.A growing number of Congress members and accounting experts say it's time for Congress to start using the audited financial statement when it makes budget decisions. They say accurate accounting would force Congress to show more restraint before approving popular measures to boost spending or cut taxes.“We're a bottom-line culture, and we've been hiding the bottom line from the American people,” says Rep. Jim Cooper, D-Tenn., a former investment banker. “It's not fair to them, and it's delusional on our part.”The House of Representatives supported Cooper's proposal this year to ask the president to include the audited numbers in his budgets, but the Senate did not consider the measure.Good accounting is crucial at a time when the government faces long-term challenges in paying benefits to tens of millions of Americans for Medicare, Social Security and government pensions, say advocates of stricter accounting rules in federal budgeting.“Accounting matters,” says Harvard University law professor Howell Jackson, who specializes in business law. “The deficit number affects how politicians act. We need a good number so politicians can have a target worth looking at.”The audited financial statement — prepared by the Treasury Department — reveals a federal government in far worse financial shape than official budget reports indicate, a USA TODAY analysis found. The government has run a deficit of $2.9 trillion since 1997, according to the audited number. The official deficit since then is just $729 billion. The difference is equal to an entire year's worth of federal spending.Congress and the president are able to report a lower deficit mostly because they don't count the growing burden of future pensions and medical care for federal retirees and military personnel. These obligations are so large and are growing so fast that budget surpluses of the late 1990s actually were deficits when the costs are included.The Clinton administration reported a surplus of $559 billion in its final four budget years. The audited numbers showed a deficit of $484 billion.In addition, neither of these figures counts the financial deterioration in Social Security or Medicare. Including these retirement programs in the bottom line, as proposed by a board that oversees accounting methods used by the federal government, would show the government running annual deficits of trillions of dollars.The Bush administration opposes including Social Security and Medicare in the audited deficit. Its reason: Congress can cancel or cut the retirement programs at any time, so they should not be considered a government liability for accounting purposes.The government's record-keeping was in such disarray 15 years ago that both parties agreed drastic steps were needed. Congress and two presidents took a series of actions from 1990 to 1996 that:•Created the Federal Accounting Standards Advisory Board to establish accounting rules, a role similar to what the powerful Financial Accounting Standards Board does for corporations.•Added chief financial officers to all major government departments and agencies.•Required annual audited financial reports of those departments and agencies.•Ordered the Treasury Department to publish, for the first time, a comprehensive annual financial report for the federal government — an audited report like those published every year by corporations.These laws have dramatically improved federal financial reporting. Today, 18 of 24 departments and agencies produce annual reports certified by auditors. (The others, including the Defense Department, still have record-keeping troubles so severe that auditors refuse to certify the reliability of their books, according to the government's annual report.)The culmination of improved record-keeping is the “Financial Report of the U.S. Government,” an annual report similar to a corporate annual report. (The 158-page report for 2005 is available online at fms.treas.gov/fr/index.html.)The House Budget Committee has tried to increase the prominence of the audited financial results. When the House passed its version of a budget this year, it included Cooper's proposal asking Bush to add the audited numbers to the annual budget he submits to Congress. The request died when the House and Senate couldn't agree on a budget. Cooper has reintroduced the proposal.The Federal Accounting Standards Advisory Board, established under the first President Bush in 1990 to set federal accounting rules, is considering adding Social Security and Medicare to the government's audited bottom line.Adding those costs would make federal accounting similar to that used by corporations, state and local governments and large non-profit entities such as universities and charities. It would show the government recording enormous losses because the deficit would reflect the growing shortfalls in Social Security and Medicare.The government would have reported nearly $40 trillion in losses since 1997 if the deterioration of Social Security and Medicare had been included, according to a USA TODAY analysis of the proposed accounting change. That's because generally accepted accounting principles require reporting financial burdens when they are incurred, not when they come due.For example: If Microsoft announced today that it would add a drug benefit for its retirees, the company would be required to count the future cost of the program, in today's dollars, as a business expense. If the benefit cost $1 billion in today's dollars and retirees were expected to pay $200 million of the cost, Microsoft would be required to report a reduction in net income of $800 million.This accounting rule is a major reason corporations have reduced and limited retirement benefits over the last 15 years.The federal government's audited financial statement now accounts for the retirement costs of civil servants and military personnel — but not the cost of Social Security and Medicare.The new Medicare prescription-drug benefit alone would have added $8 trillion to the government's audited deficit. That's the amount the government would need today, set aside and earning interest, to pay for the tens of trillions of dollars the benefit will cost in future years.Standard accounting concepts say that $8 trillion should be reported as an expense. Combined with other new liabilities and operating losses, the government would have reported an $11 trillion deficit in 2004 — about the size of the nation's entire economy.The federal government also would have had a $12.7 trillion deficit in 2000 because that was the first year that Social Security and Medicare reported broader measures of the programs' unfunded liabilities. That created a one-time expense.The proposal to add Social Security and Medicare to the bottom line has deeply divided the federal accounting board, composed of government officials and “public” members, who are accounting experts from outside government.The six public members support the change. “Our job is to give people a clear picture of the financial condition of the government,” board Chairman David Mosso says. “Whether those numbers are good or bad and what you do about them is up to Congress and the administration.”The four government members, who represent the president, Congress and the Government Accountability Office, oppose the change. The retirement programs do “not represent a legal obligation because Congress has the authority to increase or reduce social insurance benefits at any time,” wrote Clay Johnson III, then acting director of the president's Office of Management Budget, in a letter to the board in May.Why the big difference between the official government deficit and the audited one?The official number is based on “cash accounting,” similar to the way you track what comes into your checking account and what goes out. That works fine for paying today's bills, but it's a poor way to measure a financial condition that could include credit card debt, car loans, a mortgage and an overdue electric bill.The audited number is based on accrual accounting. This method doesn't care about your checking account. It measures income and expenses when they occur, or accrue. If you buy a velvet Elvis painting online, the cost goes on the books immediately, regardless of when the check clears or your eBay purchase arrives.Cash accounting lets income and expenses land in different reporting periods. Accrual accounting links them. Under cash accounting, a $25,000 cash advance on a credit card to pay for a vacation makes the books look great. You are $25,000 richer! Repaying the credit card debt? No worries today. That will show up in the future.Under accrual accounting, the $25,000 cash from your credit card is offset immediately by the $25,000 you now owe. Your bottom line hasn't changed. An accountant might even make you report a loss on the transaction because of the interest you're going to pay.“The problem with cash accounting is that there's a tremendous opportunity for manipulation,” says University of Texas accounting professor Michael Granof. “It's not just that you fool others. You end up fooling yourself, too.”Federal law requires that companies and institutions that have revenue of $1 million or more use accrual accounting. Microsoft used accrual accounting when it reported $12 billion in net income last year. The American Red Cross used accrual accounting when it reported a $445 million net gain.Congress used cash accounting when it reported the $318 billion deficit last year.Social Security chief actuary Stephen Goss says it would be a mistake to apply accrual accounting to Social Security and Medicare. These programs are not pensions or legally binding federal obligations, although many people view them that way, he says.Social Security and Medicare are pay-as-you go programs and should be treated like food stamps and fighter jets, not like a Treasury bond that must be repaid in the future, he adds. “A country doesn't record a liability every time a kid is born to reflect the cost of providing that baby with a K-12 education one day,” Goss says.Tom Allen, who will become the chairman of the federal accounting board in December, says sound accounting principles require that financial statements reflect the economic value of an obligation.“It's hard to argue that there's no economic substance to the promises made for Social Security and Medicare,” he says.Social Security and Medicare should be reflected in the bottom line because that's the most important number in any financial report, Allen says.“The point of the number is to tell the public: Did the government's financial condition improve or deteriorate over the last year?” he says.If you count Social Security and Medicare, the federal government's financial health got $3.5 trillion worse last year.Rep. Mike Conaway, R-Texas, a certified public accountant, says the numbers reported under accrual accounting give an accurate picture of the government's condition. “An old photographer's adage says, ‘If you want a prettier picture, bring me a prettier face,' ” he says.

Iran awarded Venezuelan President Hugo Chavez its highest state medal on Sunday for supporting Tehran in its nuclear standoff with the international community, while Chavez urged the world to rise up and defeat the U.S., state-run media in both countries reported.The leftist Venezuelan leader also condemned Israel for what he called the "terrorism" and "madness" of its attacks in Lebanon, Venezuelan state television reported.

"Let's save the human race, let's finish off the U.S. empire," Chavez said. "This (task) must be assumed with strength by the majority of the peoples of the world."Iranian President Mahmoud Ahmadinejad presented Chavez with the Islamic Republic Medal in a ceremony at Tehran University. The award was to show Iran's gratitude for his "support for Iran's stance on the international scene, especially its opposition to a resolution by the International Atomic Energy Agency," Iranian state-run television said."He is the one who has resisted imperialism for years and has defended the interests of his and other Latin American countries," Ahmadinejad was quoted as saying.In February, Venezuela opposed an IAEA decision to report Iran to the U.N. Security Council over its disputed nuclear program.A draft proposal Friday by permanent members of the U.N. Security Council gives Iran until the end of August to suspend uranium enrichment or face the threat of economic and diplomatic sanctions.The U.S. accuses Iran of seeking nuclear weapons. Tehran maintains its program is purely peaceful and aimed at generating electricity.

Chávez, who was on a three-day trip to Russia, did not make this statement while carousing at a local strip club. He was marveling at the IzhMash factory's female production-line workers assembling one of the famous Kalashnikov AK-47 assault rifles. He had just made a deal to buy 100,000 of them. And that's not all he bought on his Russian shopping spree. There are also fighter aircraft, advanced radars, and other assorted baubles for Vene zuela's air force.The AK-47, the weapon of choice for armies and insurgent movements around the world, was invented in Izhevsk, about 600 miles east of Moscow. Its designer, Mikhail Kalash nikov, spent most of the first 70-odd years of his life toiling in obscurity--not traveling outside of Russia until the fall of communism, when the export of Russian weapons became big business. Today, at 86, he is treated like a combination rock star/elder statesman at international defense expositions, where he is often seen wearing his Hero of the Soviet Union medals and other decorations. In the last two years, he has even launched his own brand of vodka.But the success the AK-47's designer has had at promoting his brand has not been mirrored in the sales of his famous rifle. Earlier this year, Vladimir Grodetsky, the CEO of the IzhMashfactory, bemoaned the fact that Russia makes only 10 to 12 percent of the sales of the more than one million AK-47s purchased on the world market each year. "The rest are unlicensed copies," he said in a press conference this past April.Chávez's visit to the factory and the extensive list of agreements he signed the next day at a pomp-and-circumstance-style Kremlin cere mony are all about reversing this trend. Russia makes a number of large weapons systems--fighter aircraft, naval vessels, air defense systems--that it has sold to China and India for billions of dollars, but it has had less success with smaller weapons. More important, it has yet to make a big dent in the Latin American market.Latin America is one of the last unexplored frontiers in the weapons-export business, as the previous money-making venues in the Pacific Rim and the Middle East have--for the time being--purchased about all they can afford for the next several years. Most of Latin America's air forces operate an odd mix of older model U.S. and French aircraft, many of which date to before the weapons embargoes that were clamped on South American dictatorships in the late 1970s. Some of these aircraft have been modernized by Israeli firms in the years since as a stop-gap, but it is only recently that the new Latin American democracies--unencumbered by those sanctions--have begun to rearm themselves with more modern weaponry.The Chilean air force took delivery this year of the first of a batch of Lockheed Martin F-16s, and last year Brazil signed an agreement with France to purchase a number of used Dassault Mirage 2000 fighters from the French air force. Previously, Brazil's navy had purchased the Clemenceau-class aircraft carrier Foch from France, since renamed the S o Paulo, and equipped it with a wing of Douglas A-4 Skyhawk carrier aircraft that it acquired used from the Kuwaiti air force.Russia has had no such luck on this continent. A handful of Russia's most advanced fighter jets, the Mikoyan MiG-29, were sold to Peru in the early 1990s, but these were used aircraft purchased not from Russia but from its neighbor, Belarus.Chávez's visit and the impressive list of arms deals he signed give the Russians their first big weapons bonanza in Latin America, and enemies of Chávez, in Washington and elsewhere, another big headache. He has already taken delivery of 30,000 of the 100,000 AK-47s. Concern that many of these assault rifles might end up in the hands of Colombian rebels or the drug lord armies in the favelas around Rio de Janeiro is well-founded. But the more serious dangers created by the new Caracas-Moscow axis are longer-term and can be found in the other deals the two have reached.The total bill for Venezuela's arms purchases in Russia will exceed $1 billion and includes 24 Sukhoi Su-35 Super Flanker fighter aircraft--a system so advanced that not even the Russian air force has this model in its inventory yet. Based on the famous Su-27 and Su-30MK fighters, the Su-35 is a slightly larger, more powerful, modernized version of its predecessors. It will incorporate the latest in avionics and weapons systems, including a radar system superior to that used by the Indian air force's Su-30MKIs, which defeated U.S. Air Force F-15 and F-16 aircraft in recent joint exercises. It will make Venezuela the big kid on the block in South America and will significantlyincrease the striking range of the Venezuelan air force. Chávez could conceivably now offer air support against the Americans to his friend Fidel Castro should the United States decide to take action against Cuba in the future.There are also things to worry about in the nondefense deals that are ancillary to these arms sales contracts. Chávez is known to be incensed at the embargo on spare parts and other military assistance that the United States has placed on his country, and on two occasions he has threatened to sell the F-16s his country acquired in the 1980s during a period of good relations with Washington. On one occasion he said he would give them to the Cuban air force. Later, he suggested he might sell them instead to Iran. Although these are older export models of the F-16A/B series and are far outclassed by those operated by the U.S. Air Force today, turning them over to either of those nations would represent a technology jackpot for those dictators and a blow to U.S. interests.The other half of the Venezuela-Russia dealings last week is just as disturbing. That's the oil deal Chávez agreed to in a meeting with LUKoil president Vagit Alekperov in Volgograd. The Russian oil company will start exploration in two areas of Venezuela, one of which, near the Orinoco River, is thought to contain substantial oil reserves.Experience shows that when Moscow signs big weapons sales and energy deals, the tentacles of Russian organized crime are not far behind. Russia recently signed an even larger arms-plus-oil-and-gas deal with Algeria, in which the energy sector payoffs are so large that the weapons pur chases are almost like the toy prize in a McDonald's Happy Meal by comparison. "The fighters and other weapons are practically being given away in this deal," said one Moscow-based aerospace industry analyst, "and the sums of money that are being bandied about are so large it is frightening."When the Russian mafia first became a concern in the mid-1990s, former CIA director James Woolsey testified before Congress that "if an American businessman meets with a nattily dressed and articulate Russian who claims that he is with an international trading and banking firm in Moscow and he would like to discuss a joint venture covering, say, the export of Russian oil, such an individual may be what he says he is. Or he may be a Russian intelligence officer operating under commercial cover. Or he may be an important member of a Russian organized crime group. But the really interesting point is that there is a reasonable chance that he is all three--and that none of those three institutions sees any problem with such an arrangement."And it is just such an "arrangement" that the United States may find on its doorstep thanks to the Venezuelan president. AK-47s can come from almost anywhere these days--50 countries use this infantry weapon, and six of them even include it as an icon on their nation's coat of arms. But problems on a scale this mega-deal could cause in the Americas can only come from Moscow.Reuben F. Johnson is the defense correspondent for Aviation International News and for Military Periscope, a Washington-based defense information service.